HMOs

Insurance companies use health maintenance organizations (HMOs) to control costs. Imagine that a doctor is about to prescribe some pills for an insured patient. There are two kinds of pills the doctor could prescribe. They’re both approximately of the same quality, but one costs a lot more. If the patient is fully insured, he won’t care about the pill’s expense. If the doctor has no incentive to worry about the pill’s cost either, she might prescribe the more expensive pill. The health insurance company probably wouldn’t be able to tell for certain that the patient didn’t need the expensive medication and consequently they might end up paying for the costly medicine.

Now imagine that this same doctor is part of an HMO. This HMO both provides care and insurance to its patients. The HMO will pay doctors more if the doctors keep expenses down. The doctor now has an incentive to reduce costs. What if the patient really needed the more expensive treatment? Well, the doctor would still have an incentive not to prescribe it, but at least the patient’s health insurance costs would be lower.